Sunday, October 16, 2005

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.High valuation of 20X trailing PE and bubbling optimism due to irrational target prices being set

2.Execution risk is higher for new markets given lack of incumbent knowledge

The market always churns out new trading ideas based on ridiculous price targets. This is to get small investors to buy in by anchoring their psychology to that ridiculous target valuation and then when the music stops....

This has been played out successfully before. Just look at Beauty China. Remember that the "re-rating" for Beauty China then was done in synchronisation with a big share placement --- an old trick. Now we have Best World, incidentally selling the same kind of products -- cosmetics products. Its sourcing, formulation and distribution of health and lifestyle products also brings another company to mind ---Lifebrandz.

If there is anything the above two stocks --- Beauty China and Lifebrandz --- have taught those willing to learn, it is that one should not discount the volatility and risks inherent in the consumer products sector; the profits can be quite volatile. Consequently, one should not overly project into the future, leaving no margin of safety. The latest CLSA analyst report put the price target at 75 cents based on 10X FY05 forward PE. OK that sounds fine except that the share price is now somewhere near there. However, the report further claims that it could re-rate to 15X FY07 PE suggesting a target price of $1.80-$2. That got small investors all excited.

The stock has risen to a price level that is virtually unsustainable. It is trading at 20 times trailing PE, 6 times NTA. Its revenue base is a paltry S$30M (based on FY04). It is a SESDAQ stock which usually means lower valuation given lower listing requirements. One of its key shareholders (Derek Goh) has been trimming his stake steadily from 10% down to below 5% (which means now he doesn't need to declare future transactions -- beware!).

One might notice I haven't talked about the direct selling business model of Best World so far. That's because I think if it is so great every business would be practising it already. The founders have had some previous experience in the MLM business before they founded the company so their execution risk is less for the Singapore market. However their growth drivers are now supposed to be the Indonesia and Thailand markets --- that would involve considerable execution risk given the presumable lack of contacts. Product liability risk is higher here than in traditional consumer products brand OEMs; my understanding is that the level of training of distributors in direct selling as well as the product quality control is typically lower; it is an inherent characteristic of the business model. And don't even compare Best World to Amway Malaysia and say the high valuation of the former is justifiable given that the latter is trading at 20 times PE. Amway Malaysia has a parent in the US which is the world's largest direct selling company. Best World is nowhere near that.

Most people would be familiar with the MLM strategy. The people at the top layer earn the most while the downstream distributors earn peanuts (not the $600k kind of peanuts). One can relate this to the Best World shares. The early entrants like Derek Goh catch good capital gains; those late in better be careful lest they end up carrying the baby from the upstream and finding no downstream players to distribute to.

Re: "It is trading at 20 times trailing PE, 6 times NTA. Its revenue base is a paltry S$30M (based on FY04)"

You have overlooked the FY05 figures: 10X PE and revenue of about $60 million, based on annualising 3 quarters of results.Considering that Best World has delivered high growth rates so far this year and in the past 3 years since direct selling was liberalised in S'pore, you should have considered the latest current figures instead of FY04 numbers.

anonymous,Don't think there's a 3Q results for Best World, only 1H. Since Best World is a recent IPO (I generally disregard pre-IPO results in assessing track record given less stringent reporting criteria) and it's only 1H results I prefer to use trailing PE. Only when it's maybe 3Q results would I consider annualising. Typically, my use of trailing PE also acts as a safety margin for me, if you understand what I mean.